It’s  a Central Banker's World; We Just Live in It

We've devoted a good deal of space over the past few months discussing central banks and monetary policy. We've focused on ours – the Federal Reserve – and theirs – the European Central Bank (ECB). These are the two most important central banks in the world.

Usually, we'd focus on matters purely housing or mortgage related – sales, prices, mortgage rates, underwriting rules, etc. Thing is, the Federal Reserve and the ECB have taken center stage. These institutions have never been as influential as they are today.

It's all about the money.

The Federal Reserve was responsible for flooding the U.S. economy with new money after the housing-market collapse in 2008. The Fed injected nearly $4 trillion through quantitative easing (QE) – buying Treasury notes and bonds and MBS with newly issued money. A drop in mortgage rates and new money flowing into housing were the intended consequences. Mortgage rates fell and housing prices rose.

We mentioned last week that the ECB had torn a page from the Fed's playbook. It will implement its own version of QE. It might seem a stretch for the European Union's central bank and its monetary policies to influence U.S. markets, but they do.

The yields on U.S. debt instruments are higher than those on European debt instruments of similar vintage and quality. This means more European money flows into U.S. debt. Prices rise and yields fall. Today, the yield on the 10-year U.S. Treasury note – an influencing instrument for 30-year fixed-rate mortgages – is below 1.8%. Not surprisingly, rates on the 30-year mortgage remain well below 4%. (Historically, the 30-year loan has averaged two percentage points more than the 10-year note.)

The ECB's commitment to easy money and low interest rates will also influence Federal Reserve policy. The best guess among most economists is that the Fed will begin raising the fed funds rate – an influential short-term rate – in June. The ECB's new monetary policy puts that guess on shakier ground. It appears more likely to us that the Fed will push back raising the fed funds rate unit the third quarter.

With all this new money sloshing around in the world's economies, it's extraordinary that consumer price inflation has failed to take off. In the United States, consumer price inflation runs below 2% annually. In Europe, deflation, not inflation, is the greater concern. Money remains in high demand. That's reflective of heightened uncertainty.

Our best guess is that interest rates in general and mortgage rates in particular will hold current lows through the first quarter. Unless there is a blockbuster jobs reports or an unexpected surged in economic growth, there is simply no reason for rates to rise. That said, it's always worth remembering that markets are marked by trend-reversing surprises. Therefore, there are no guarantees.

Information provided by Jessica Regan.

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